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A Formula for Bull and Bear Markets

Jensen Portfolio fund's performance has beaten the S&P 500 over the past ten years -- with less risk.

By Andrew Tanzer, Senior Associate Editor
September 17, 2009

Market fads come and go, but Jensen Portfolio (symbol JENSX) sticks to its knitting. The fund's managers, headquartered in Lake Oswego, Ore., invest in high-quality, U.S. growth companies, which co-manager Bob Millen argues are still attractively priced in a market that he thinks is currently fully valued.

Jensen's formula has worked well in both bull and bear markets. Over the past ten years through September 14, the fund returned an annualized 4%, an average of four percentage points per year better than Standard & Poor's 500-stock index and five points a year in front of the average large-company growth fund. Year-to-date through September 14, Jensen gained 17.1%, trailing the index by 1.2 points.

Moreover, Jensen achieved those market-beating returns while taking less risk than the overall stock market. Over the ten-year period that ended June 30, the fund captured 96% of the return in up markets but suffered only 65% of the losses in down markets.

Millen defines quality growth companies as those that have solid balance sheets and are capable of consistently improving earnings at a rate higher than the average publicly traded company. Concerns such as these tend to have sustainable competitive advantages and high returns on investment, and they generate abundant excess cash, which can be reinvested in the business or used to buy back shares or pay a dividend.

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Jensen sets a high bar in choosing stocks to own. It considers only U.S. companies with market values in excess of $1 billion that have produced returns on equity -- a measure of profitability -- of 15% or more for at least ten consecutive years (the fund has cut loose holdings such as Wells Fargo and Intel for dropping below the 15% threshold). The universe of companies that makes the cut is about 150, from which the portfolio typically holds 25 to 30 names. Fund turnover is low, typically less than 15% a year.

Jensen buys these great businesses only when they become great stocks -- that is, when they're priced at a 20% to 40% discount to Jensen's estimate of a company's intrinsic, or true, value. The managers base their determination of a company's intrinsic value on their estimate of the amount of free cash flow (the cash profits that are left after the capital expenditures needed to maintain the business) it is likely to generate over the next ten years.

Two things that Millen finds particularly attractive these days are powerful intellectual property, such as patents or brands, which helps a business stave off competition, and strong overseas operations. "Over the next two to five years, we believe the U.S. economy will be in a slower-growing mode, and therefore those companies with significant global footprints will be able to take advantage of faster-growing economies," he says.

One longtime position is Colgate-Palmolive (CL), which Millen says has "all the characteristics that we look for in a company." Colgate has a competitive advantage because it has built a stable of superior brands over the course of decades. That helps the company generate towering returns on capital that are vastly in excess of its capital costs. Nearly 80% of revenues are generated overseas, much of them in expanding developing nations in Latin America and Asia.

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Jensen's largest holding at last report was 3M (MMM). Selling 55,000 products in 200 countries (64% of sales are booked abroad), innovative 3M is loaded with intangible assets, such as patents that don't show up on the balance sheet. Millen notes that 3M's return on equity has averaged 30% over the past ten years and that, like Colgate, it has a nice habit of boosting the dividend every year.

A newer holding is Oracle (ORCL), the leader in enterprise software. The programs themselves are Oracle's main intangible assets, and Millen particularly likes the way the company generates recurring revenue from clients through software license updates. The bulk of overall revenues comes from foreign markets. Oracle's return on equity over the past decade has averaged a plump 43%.

The annual expense ratio for Jensen's Class J shares is 0.86%, and the minimum investment is $2,500.